(Bloomberg) -- Actively managed ETFS are surging in Canada, expanding an ETF market already dominated by BlackRock's iShares and posing a challenge to the mutual-fund industry that Morningstar says has among the highest management fees in the world.
Assets in actively traded ETFs jumped to about $7.33 billion as of May 31, up almost 50% from a year ago, according to data compiled by Bloomberg. The funds have also outperformed their index-tracking ETF peers this year and now make up about 11% of Canada's $69-billion ETF industry, the most among developed markets, the data show.
"Actively managed ETFs have been the largest driver of asset growth for our business over the last three years," said Steve Hawkins, co-chief executive officer of Horizons ETF Management Canada, best known for its leveraged ETFs. More than half of Horizon's $3.7 billion AUM are now actively traded funds, Hawkins said.
The rise in active ETFs come as Canadian securities regulators implement new rules to improve cost transparency in a country where mutual-fund fees are the world's highest, according to a Morningstar report.
Under Client Relationship Model Phase 2 amendments, firms will be required to provide more detailed account statements, and beginning in 2016 will have to submit annual reports to clients showing how much advisers were paid for products and services.
MOST EXPENSIVE
"For investors who want to remain in active funds, Horizons will start to look a lot more attractive," said John Gabriel, an analyst at Morningstar in Chicago. "With their ETFs they're looking to take a chunk of the mutual-fund pie. People may see their products and start to migrate."
Canadian mutual funds received a grade of D- on fees, the worst out of 25 countries in a June Morningstar report. The U.S., Australia and the Netherlands tied for the best scores in the gauge, which measures ratios across different categories. Canadian management expense ratios average 0.61% for ETFs and 1.86% for active mutual funds, according to Morningstar. Active ETFs average 0.66%, Bloomberg data show.
Ian Bragg, senior manager of research and statistics at Investment Funds Institute of Canada, disagrees with Morningstar's findings. He argues that while Canadian fees generally include embedded distribution and adviser costs, those elements are stripped out of U.S. fees, making them appear lower.
COMPETITION LACKING
Canada also suffers from a lack of price competition, economies of scale and a smaller environment of independent investors, Morningstar said.
Horizons Active Canadian Dividend ETF has fees of 0.7% and posted a total return of 63% in the past five years, compared with 50% for its benchmark, the S&P's/TSX Canadian Dividend Aristocrats Index.
Actively managed ETFs in Canada climbed 4.1% on average in the 12 months through June 29, compared with a 2.5% advance in passive ETFs, according to data adjusted for asset size compiled by Bloomberg. Active equity ETFs have surged 6.9%, ahead of a 2.8% advance for passive equity ETFs, the data show.
FUNDS STRUGGLE
While active ETFs are taking off in Canada, they account for only about 1% of the $2.1 trillion U.S. ETF market. Meanwhile the return of U.S. active ETFs has dropped 1% in the past year, compared with a 2.6% increase for passive.
The funds have struggled to gain traction in the U.S. because Americans tend to put more emphasis on cost when choosing investment vehicles to save for retirement, said Eric Balchunas, a Bloomberg analyst in Skillman, N.J.
As well, in contrast to the U.S., Canadian regulators don't require firms to disclose their holdings daily, Hawkins said. That reduces concerns over competitors front-running trades.
On the bond front, active ETFs don't always have to sell assets to match an index's move, reducing liquidity qualms, he added. Horizon's $437 million Active Corporate Bond ETF, managed by Fiera Capital, is among the firm's best sellers.
INVESTMENT TESTBED
Hawkins, 47, took over in March as co-CEO of Horizons, a unit of Seoul-based Mirae Asset Global Investments Co. It faces growing competition in actively managed ETFs including from First Asset Investment Management, which has rolled out several products since September, including the First Asset Active Canadian Dividend ETF.
Canada has been an investment test-bed since it debuted the world's first ETF in 1990 with the Toronto 35 Index Participation Units. Horizons launched the world's first leveraged commodity ETF in 2008. Its more recent products have included an ETF based on trades of corporate insiders.
ETF assets climbed to a record $66 billion as of May 31, according to data from the Canadian ETF Association. Horizons has a 5.5% market share while BlackRock's iShares has 54%, followed by Bank of Montreal and Vanguard.
The industry remains small compared with the mutual fund market, whose assets have advanced 8% this year to a record $97 billion as of May 31, according to data from the Investment Funds Institute of Canada. "I don't think we're feeling any particular threat from ETFs," IFIC's Bragg said. "We see mutual funds and ETFs as different products serving different needs and they can work together."
Still, some of Canada's biggest mutual fund providers are investigating getting into ETFs.
